Aeronautical engineer Rolls-Royce (LSE: RR) has been on a tear lately. Its shares are up around 170% over the past year. But that still leaves them 30% below where they stood five years ago.
Given the apparently strongly improving business performance and a share price that is still a long way beneath historical highs, should some Rolls-Royce shares be on my shopping list for November?
The business performance is improving
Let me start with that business performance. The company announced a job-cutting drive this month that foresees several thousand roles being axed, alongside efforts to save costs through organisational redesign.
That comes on top of the half-year results in August. They showed some clear grounds for optimism about where the business is going. Revenues jumped 34% year-on-year, while an interim pre-tax loss of £1.8bn last time around was turned into a £1.4bn pre-tax profit in the first six months of this year.
Underlying revenue growth was strongest in the key civil aerospace division. But the power systems and defence businesses also recorded double-digit percentage growth compared to the prior year period.
During the summer, the company lifted its full-year underlying profit guidance to £1.2bn-£1.4bn.
Inconsistent earnings track record – and ongoing risks
So far, so good. It definitely seems as if the engineer has strong tailwinds, for now. But I think that has already been largely reflected in the impressive rise seen over the past year in Rolls-Royce shares.
Massive dilution during the pandemic, when more shares were issued to help raise funds, means that even getting back to old profit levels will not equate to the same earnings per share. Basic earnings per share were 14.7p in the first half. Back in 2017 (allowing for a subsequent restatement), they were over four times as much for the equivalent period.
Then again, the following year’s interim results saw the company crash to a big loss. Even before the pandemic hurt demand for engine sales and servicing, Rolls-Royce had a poor track record when it came to consistently turning a profit.
The industry in which it operates has high fixed costs. The latest cost-cutting moves could help. But I see an ongoing risk that when the next unexpected downturn hits the aviation industry, profitability at aeronautical engineering firms including Rolls-Royce could slump.
But what about the share price?
It is those long-term risks that put me off the idea of buying Rolls-Royce shares at the current price.
Looking at the first half earnings and improving business performance, the valuation looks cheap. After all, Rolls-Royce has a storied brand, large customer base and operates in an industry with high barriers to entry.
But the basic economics of that industry also concern me. Sudden drops in civil aviation passenger numbers can hurt profitability badly – and there is a risk this will happen again. So from a long-term perspective, I do not see Rolls-Royce shares as a bargain and have no plans to invest.
